Sun Goes Up, Sun Goes Down

Understanding Market Volatility

Posted on: 02/10/2016

Market volatility is as much a part of investing as the sun going up and down is each day. The irony is we never seem to get upset at the sun behaving normally, yet we often criticize the fact that markets do. It seems very few of us want to deal with the fact that markets are volatile. We think as soon as markets move downward something is wrong. The reality is markets have cycles—periods of upward, downward, and even flat or nearly non-existent movement. The trick is, nobody knows how long each cycle lasts, which is where our emotions step in.

From a behavioral standpoint, nobody is acting abnormal when they present they can’t handle the extreme volatility we sometimes experience in the market. The danger is when we allow ourselves to believe that we can’t stomach it and feel forced to sell out when our portfolio is low. All we are doing at that point is locking in our losses. Just because markets are down doesn’t mean you’ve lost money (at least officially). As long as you haven’t sold the position, it is an “unrealized loss”. It can just as easily become an “unrealized gain” the next day if the markets were to rebound, but most of us won’t make an issue of it because we don’t lose sleep over good news.

The last year [2015] was incredibly volatile, yet nearly flat if you consider where it started Jan 1st and where it ended the last day of the year. Interestingly enough, the previous 5 years all ended higher than when they started. So why is this year any different? Some say we’re seeing a recession again. Others state this is simply the leveling off of a peak. But nobody really knows the exact reason and probably never will. That’s why it’s important to not allow market conditions to dictate when you invest your money. It’s more important to have a properly diversified portfolio that experiences gains as well as losses to help offset some of the volatility. It doesn’t mean you aren’t going to have volatility—that comes naturally with taking on risk. But the amount of volatility you experience can be reduced, if you will, by diversifying across a broad base of asset classes.

So the question becomes, “How will my portfolio be affected over time if all my money was put in at the height of a market?” We obviously know that if you were lucky enough to get in at the bottom of every cycle, you’d be sitting pretty right now; but few if any have been able to time it that perfectly.

The good news is we actually have data that shows what you could expect if you were to invest at the peak of each market. And the reality is, in every case, 10 years after the peak, your money ended up being more than your original investment, even experiencing the down cycles. [see attached data]

The data considers peak years in the market over the past four decades; namely: 1973, 1987, 1990, 1998, 2000, and 2007. In each case, 10 years later the portfolio was more than what it was even investing in the height of the peak and experiencing whatever volatility followed.

So if you’re an investor and worried about when to get into the market, stop worrying. As long as you’re in it for the long haul and not preoccupied with the short term, your portfolio should be fine. It turns from trying to time the market into time in the market.